The recent developments in the U.S. economy and its intricate network of international debts and credits have resolved lingering uncertainties. On Monday, Mark Yusko, Chief Investment Officer at Morgan Creek Capital Management, shared his insights on CNBC:
“…we’re heading towards a scenario reminiscent of 1928-29 when Hoover was in office. Now Trump is president. Both of them entered office without prior experience, supported by a Republican Congress filled with substantial promises that ultimately went unfulfilled. The decline typically occurs when people wake up to the reality that things haven’t unfolded as anticipated.”
“By the fall, we will see clearer evidence of waning growth. We’ve already begun to witness a decline.”
To recall, the autumn of 1929 marked the beginning of a significant stock market crash in the U.S., leading to a decade-long Great Depression. This is the trajectory that Yusko believes we are currently on—one that poses tremendous risks to investors’ wealth.
For instance, between September 3, 1929, and November 13, 1929, the DOW experienced a staggering loss of 47.9 percent. Remarkably, it then rebounded by 48.1 percent by April 17, 1930. This temporary uptick misled many investors into re-entering the market, just in time for the devastating downturn that followed.
Ultimately, this was a classic case of a “suckers’ rally,” leading to a catastrophic market decline of 89.2 percent from its peak, crushing the hopes and dreams of an entire generation. One might assume that such a monumental failure could never recur—right?
Unknown Road Ahead
Indeed, the prospect of even a partial repeat of the 1929-32 stock market collapse is a warning that should not be overlooked. Historical occurrences serve as reminders that if it has happened once, it has the potential to happen again.
In addition to the political parallels mentioned by Yusko—specifically, fiscal policies under a Republican President and Congress—the economy is also navigating tightening monetary policies akin to those of 1929. However, today’s journey includes new challenges, leading us down a path that remains largely uncharted.
The Federal Reserve faces a considerable challenge in pursuing its goal of policy normalization. While elevating the federal funds rate is one undertaking, navigating the complexities of quantitative tightening is another, and one that the Fed has yet to experience.
Jamie Dimon, CEO of JPMorgan Chase & Company, emphasized the uncertainty surrounding the implications of reversing quantitative easing (QE). Speaking at a conference in Paris on Tuesday, Dimon stated:
“We’ve never had QE like this before; we’ve never had an unwinding quite like this before. This inherently should raise concerns about the potential risks, as we lack historical context.”
“When significant quantitative tightening occurs, it might be even more disruptive than people anticipate. We act as if we have a clear understanding of how it will unfold, but we really don’t.”
Adventures in Quantitative Tightening
Dimon is undoubtedly correct—no one, not even the Fed, can predict precisely how reducing the Fed’s balance sheet will manifest. This is unprecedented territory.
However, Dimon might not capture the full gravity of the situation. Quantitative tightening is unlikely to be merely “a little more disruptive” as he posits; rather, it could be far more destructive than many can envision.
Dimon’s comments drew the attention of Representative David Kustoff from Tennessee. During Janet Yellen’s semiannual testimony before Congress, Kustoff queried whether she shared his apprehensions regarding the Fed offloading assets from its balance sheet.
While Yellen did not provide a straightforward affirmation or denial, she presented her well-honed ability to downplay the possible repercussions of the Fed’s previous actions:
“We have made a concerted effort to keep the public and market informed about our plans. We’ve communicated extensively, and we haven’t observed significant concerns or notable market reactions.”
However, the reaction resulting from carefully crafted policy communications is vastly different from the response expected when central banks begin shedding large quantities of sovereign debt at the same time. In the spirit of thoughtful speculation, we present various intuitions and insights regarding the potential implications of quantitative tightening. These are not predictions but serve as a jumping-off point for your own speculations about the future…
- Interest rates are anticipated to rise.
- Asset prices—encompassing bonds, stocks, and real estate—will likely decline.
- Credit will tighten, potentially destabilizing the economy’s fragile foundation.
- GDP may shrink, while unemployment could rise amidst dwindling labor participation.
- Having cash on hand will initially be advantageous; however, several too-big-to-fail banks might collapse.
- Numerous municipalities and states could face bankruptcy, with Hartford and Illinois already experiencing significant challenges.
- The Fed may need to change course dramatically, yet attempts to push interest rates below zero by ramping up its balance sheet may prove insignificant in halting an economic downturn.
- Consequently, the Fed might resort to directly injecting fiat money into the economy, perhaps through monthly electronic tax rebate cards sent to both taxpayers and non-taxpayers. This could ignite a swift devaluation of the dollar, alongside other fiat currencies, as central banks launch similar initiatives, resulting in grocery store shortages.
- In dollar terms, gold and silver prices are expected to soar, likely leading to governmental confiscation. Following this, events may take a turn for the worse.
Alternatively, everything might proceed without a hitch. As Yellen told Kustoff, “I expect, and certainly hope, that this will go smoothly and will be a gradual and orderly process.”
However, it may be wise not to hold your breath.
Sincerely,
MN Gordon
for Economic Prism
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